Friday 30 August 2019

Forensic Audit in Karol Bagh


CA. Ashwani Rastogi, one of the partner certified as FAFD from ICAI for Forensic audit. associated with team of Five partners in firm.

Bank forensic fraud detection techniquesSource: IIM, Bangalore Working Paper

Fraud detection procedure in public sector banks: The authors analyzed the
process of fraud detection and reporting in a public sector bank and who are
the various players involved in this process. Following is a step by step
illustration of the same (Figure 5).
a) First, a fraud is internally reported to senior management of a bank.
These may include chief general managers, executive directors,
chairman and managing director. They may also be reported to
vigilance department of the bank.
b) If reported to the vigilance department of the bank, it investigates the
fraud and then reports it to both senior management as well as the
central vigilance commission (CVC) to whom they are required to
report monthly.
c) Although CVC can report fraud directly to investigating agencies like
CBI, usually final decision to either report fraud to an external
agency or to deal with it internally is made by senior management of
the bank. Depending upon size of the bank, amount of money
involved in fraudulent activity and number of third parties involved.
Senior management may choose to deal with the fraud internally or
file an FIR and report it to either local police or CBI.

Bank forensic fraud detection techniquesSource: IIM, Bangalore Working Paper

d) A committee of the RBI also independently monitors fraudulent
behaviour in banks and reports its observations on quarterly basis to
central board of the RBI. The board may
then report the matter to either central vigilance commission or ministry of
finance (MoF).
e) Auditors, during the course of their audit, may come across
instances where transactions in accounts or documents point to possibility
of fraudulent transactions in accounts. In such a situation, auditor may
immediately bring it to the notice of top management and if necessary to
audit committee of board (ACB) for appropriate action.
f) Employees can also report fraudulent activity in an account, along
with the reasons in support of their views, to the appropriately constituted
authority (Table 1), under the whistle blower policy of the bank, who may
institute a scrutiny through the fraud monitoring group (FMG). The FMG
may ‘hear’ the concerned employee in order to obtain necessary
clarifications. Protection should be available to such employees under the
whistle blower policy of the bank so that fear of victimization does not act as
a deterrent.

2. Reason for higher advance related frauds in public sector banks
and rising NPAs: Higher advance related frauds of above Rs. one crore
loans (87 percent of total amount involved in loan worth Rs. one crore or
above in value) (Figure 2) in public sector banks as compared to private
sector banks (11 percent of total amount involved) could be due to the
proportion of the loan advanced by both PSBs (~ 70 percent) and private
sector banks (~ 30 percent) especially in large and long gestation projects
like infrastructure, power or mining sectors. Also, the higher number of
fraud cases reported by PSBs (65 percent of total) as compared to PVBs (19
percent of total) may be attributed to stringent oversight of CVC in PSBs. It
may also be due to a possible underreporting/evergreening of loans on the
part of the PVBs, evidenced by RBI’s measures to curb such practices in
recent times.7
The reason for large NPA’s of PSBs could be attributed to greater amount
of lending/exposure to mining, infrastructure and power sector projects,
whose performance and associated cash flows closely follow the economic
cycle of boom and recession. Also, in India, post - 2008 global crisis, a
number of governance and other external issues such as policy paralysis,
inordinate delay on account of stringent environmental laws/regulation,
Supreme Court decision on coal mines as well as weak demand crippled
these sectors and resulted into weaker cash flows. These developments
severely affected the ability of such firms to service their loans leading to
higher NPAs.

3. Third party agencies involved: Big loan advance frauds are not so
easy to commit and it often results because bank officials collude with
borrowers and sometimes even with officials of third parties such as
advocates or chartered accountants (CAs). In such cases, the third parties
such as the CAs or the advocates often get away as it is nearly impossible
for the banks to prove criminal intent on the part of such persons due to
various reasons such as lack of clear understanding of legal matters to
bankers, and lack of expertise and legal advice on this subject, and
unwillingness to reveal some sensitive data to courts/ public domain. Also,
self-regulatory bodies of advocates, auditors or accountants like bar
council and the institute of chartered accountants of India do not generally
bar their errant members. Also, in this context, cost of pursuing such
individuals and delay caused by courts often deter the PSBs.
The role of auditors was further analysed in order to identify gaps and
loopholes that exist in the current system. Auditors can be classified into
three main types:

a) Bank auditors – There are different corporate banks where two
main types of auditors work to look into financial statements of its
borrowers. They work as per their scope and knowledge. They can be held
responsible for any misreporting under common legal framework due to
faith placed on them by banks. Following are the two types of auditors:

i. Statutory auditor – These look into financial statements of all
borrowers who borrow from a bank. These are external auditors.

ii. Concurrent auditor – These help supplement for the functioning of
bank in terms of internal checks and check on financial statements of its
borrowers. These may be external/internal auditors

b) Statutory auditors of the borrower – These auditors work for the
borrower firm and help in reporting their financial statements.

c) Special auditors – These auditors work on a case by case basis
independently and are not associated with any firm or bank. They provide
an external view on statements reported by the borrowers to the bank.

4. Borrowers and clients of banks: Frauds may also arise solely from
the borrower’s side. Companies have been found to take part in ‘high sea
sales’ with investment from Indian banks but the funds are either routed
for other purpose or are not repaid after the sale has been made and
instead, routed to other channels, resulting in an NPA. Such breach of
contract is another instance of fraud since the funds are not utilized for
the purpose they were initially set up and based on the project evaluated
by the banker.

5. Legal aspects of fraud and role of investigation agencies:
Investigating and supervisory bodies like central vigilance commission
(CVC) or central bureau of investigation (CBI) are already overburdened
with many pending investigations and have limited resources at their

The biggest hurdle in pursuing fraudsters is proving criminal intent on
their part in the court of law. Most of the bank’s fraud get detected very
late and by that time, fraudsters get enough time to wipe out trails and it
becomes very difficult to establish criminal intent due to loss of relevant
documents and non-availability of witnesses.
Also, while pursuing fraudsters, banks and investigation agencies face
many operational issues. Bankers are not experts in legal paperwork, and
formal complaints against fraudsters drafted by them often due to lack of
incisiveness. Also, in absence of a dedicated department handling fraud
matters, investigating officers (CBI/police) have to deal with multiple
departments and people within the bank, which often results a poor
coordination and delay in investigation. This results a very low conviction
rate for fraudsters (less than 1 percent of total cases). Even after conviction
in fraud cases, there is no legal recourse to recover the amount lost in the
bank frauds and the country’s legal system is perceived to be very soft on
defaulters. Also, lack of strong whistle-blower protection law inhibits early
detection in case of involvement of internal employees.

6. Judicial system: The long and elaborate judicial process is an
another major deterrent towards timely redressal of fraud cases. The delay
in judiciary to prosecute those guilty of fraudulent practices, could lead to
dilution of evidence as well as significant cost building on part of the victim
Also, wilful default is still not considered as a criminal offence in India.
Fraudsters, both big and small, take undue advantage of these means of
evasion and commit maligned activities without risk of conviction.

7. Technological and coordination perspective: RBI has an elaborate
set of early warning signals (EWS) for banks to curtail frauds. However as
of now, there are inadequate tools and technologies in place to detect early
warning signals and red flags pertaining to different frauds. The authors’
interaction with a former chairman of a big public sector bank shockingly
revealed that there is only one provider of vigilance and monitoring
software for banks and price discovery is poor. Even the biggest of public
sector banks cannot afford to buy that software. Also, lack of coordination
among different banks on fraud related information sharing is an another
major roadblock.

Suggestion for an early detection of frauds by IIM- Bangalore

a) Independent specialized cadre: The government could consider an
independent specialized cadre of officers on the lines of all India services,
who are equipped with the best financial and legal know-how to detect
financial frauds and are capable of carrying out an effective and time
bound investigation of such scams. In short term, the government can
consider forming this cadre with a pool of commercial bankers, RBI and
CBI officials through lateral recruitment.

b) Know your markets: In addition to know your vendor and know
your customer, the banks should also focus on how to know your markets.
There should be a dedicated cell within each bank to assess the
company/firm to which they are lending and the macro-economic
environment of the concerned industry or market where products are
marketed. This recommendation even seems relevant in the context of the
recent crash of the Chinese market. Several Indian manufacturing
companies, which were dependent on import of machinery from China,
could not start their projects and generate cash flows, and this in-turn
affected the banks from which loans were raised.
Suggestion for an early detection of frauds by IIM- Bangalore

c) Internal rating agency: Banks should have a strong internal rating
agency, which evaluates big ticket projects before sanctioning loan. The
rating agency should strictly evaluate the project on the basis of business
model/plan of project without being influenced by brand name or credit
worthiness of the parent company, considering current macro-economic
situation and exposure of the sector to the global economy. In case ratings
of internal and external agencies are not similar then an investigation
must be conducted to establish the causes for such differences. Also, bank
should seek services of at least 2-3 independent auditors in evaluation of
such projects so as to prevent chances of any possible collusion.

d) Use of latest technology: The data collection mechanism in banks
is very archaic and needs a revision. The banks should employ the best
available IT systems and data analytics in order to ensure effective
implementation of the red flagged account (RFA) and early warning signals
(EWS) framework suggested by the RBI, which would help in a better
profiling of customers by analyzing patterns of their transactions and
rendering a near real time monitoring possible for banks. Also, we
recommend that the Institute for Development and Research in Banking
Technology (IDRBT) could consider incentivizing development of relevant
software for commercial banks at affordable costs. This is vital to enhance
their monitoring of suspicious and fraudulent transactions within the
branches of their banks.

Suggestion for an early detection of frauds by IIM- Bangalore
e) Monitoring outlier movement at regional level: The RBI could
consider extending its monitoring ambit and scope, and should monitor
the outlier movements of transactions at regional level on the lines of
SEBI’s circuit breaker, which might be effective in tracking the earliest
possible signs of financial frauds.

f) Strong punitive measures for third parties: The government should
consider examining the role of third parties such as chartered
accountants, advocates, auditors, and rating agencies that figure in
accounts related to bank frauds, and put in place strict punitive measures
for future deterrence. There is also a case to be made to question the
certification/credentials of third parties like auditors to decide their
competence in evaluating accounts containing potentially fraudulent

g) Strong laws to prevent fraudulent financial reporting: There are many
areas where the current laws can be made stronger to improve
accountability of auditors toward their jobs.

Suggestion for an early detection of frauds by IIM- Bangalore

i. One of them could be strengthening KYC norms. A benchmark in
this case can be guidelines issued by OECD to regulate trust and
corporate service providers (TCSPs) that helped extend liability of
fraudulent malpractices in these institutions to lawyers and auditors as
well. In India, NBFCs are required to act similarly by reporting about
suspicious transactional activities but this is not done effectively as these
laws are very weak in their current form.

ii. Another law that can be strengthened is that of willful default
which should be made a criminal offence. It is currently a civil offence
under Indian law, whereas it is a criminal offense in other countries.

h) Ground intelligence assets: Banks should be equipped with some
intelligence gathering agency, which might be deployed to track activities
of borrowers and is able to help the bank in ensuring real time compliance
and early detection of fraud. A special fraud monitoring agency should be
setup in banks with highly skilled/trained officials. A specialized
investigating agency is also needed with expertise from agencies such as
CBI, RBI, SEBI and commercial banks.
Suggestion for an early detection of frauds by IIM- Bangalore
i) Dedicated department for handling fraud cases: There should be a
dedicated department equipped with legal assistance in every corporate
branch of a PSB, which serves as a single point of contact with
investigating agencies and facilitates easy access to relevant documents.

j) Financial literacy: Many a times, staff does not know the exact
definition of fraud and thus needs to be educated regarding this aspect.
Therefore, learning sessions for employees and the best practices across
the world in areas of early fraud detection and prevention should be
imparted to staff on regular basis. There can be regular e-modules with ecertifications and updates made available.

k) Transparent hiring and adequate compensation: Banks have to
ensure corporate governance at the highest levels. Top management needs
to set guidelines and policies for ethical practices and standard procedures
to be followed throughout and set an example on zero tolerance to
negligence and fraudulent activities. Considering the roles and
responsibilities of top management, emphasis should be given on
appropriate hiring procedure at top management level, with appropriate
preference for minimum service of at least 3 years, with accountability
clause. Also, changes need to be incorporated on incentive mechanisms to
have a balance between short term and long term targets.

Suggestion for an early detection of frauds by IIM- Bangalore

l) Coordination between agencies: there needs to be a confidential
coordination between banks and agencies such as the Central Board of
Direct Taxes (CBDT) to share vital information on personal wealth of
promoters. In case of any information that may raise red flag, the CVC and
the RBI should jointly investigate the promoters for fraudulent activities.
Also, despite efforts, banks have not been very successful in conviction of
individuals responsible for financial crimes. One of the root causes of this
problem is identified as lack of specialized financial sleuths with knowledge
of nuances of forensic accounting as well as a good legal understanding of

Scope of Forensic Audit

The scope of Forensic audit will extend to following aspects relating to a

1. Capacity to pay: Examine as to if the borrower has defaulted in
meeting its payment/repayment obligations to the bank even when it has
the capacity to honor the same.
2. Money trail & End use of funds financed by the Bank/lenders.
3. Diversion of funds: diversion of funds on the part of borrower
would be construed in any of the undernoted occurrences
4. Utilization of short term working capital funds for long term
purposes not in conformity with the terms of sanction;
5. Deploying borrowed funds for purposes/activities or creation of
assets other than those for which the loan was sanctioned.
6. Transferring borrowed funds to the subsidiaries/group companies
or other corporate by whatever modalities.
7. Routing of founds through any bank other than the lender bank or
members of consortium without prior permission of the bank/lenders.
Scope of Forensic Audit
8. Investment in other companies by way of acquiring equities/debt
instruments without approval of lenders.
9. Shortfall in deployment of funds vis-à-vis the amounts
disbursed/drawn and the difference not being accounted for.
10.Siphoning off funds: siphoning off funds on the part of borrower would
be construed to occur if any funds borrowed from bank are utilized for
purposes un-related to the operations of the borrower, to the detriment
of the financial health of the entity and /or the lender.
11.Capital Structure: Tracing the source of contribution by promoters by
analyzing equity/debt infused by promoters/partners.
12.Abnormal trade transactions: commenting on transactions of
substantial amount, which seem not to be normal trade transactions at
arm’s length.
13.Sales: Verifying revenue from operations including checking sale order,
invoices and controls in billing process. The focus should be on inflated
turnover/ fictitious sales and /or sales on Return (SOR) basis where
profit has been booked and sales returned in the subsequent
accounting period leading to writing off of stocks/debtors and reversal
of booked profits. The sustainability of sales in future years should be
co-related with Technical and Viability (TEV) study.

Scope of Forensic Audit

14. Finding details of assets of unit / its promoter(s)/partners to ensure
recovery of loans granted by banks as there would be cases where some
assets are not reported in financials of the unit /promoters / partners.
15.Examining chain of transactions pertaining to unit
/promoters/partners to ensure genuineness of the dealings as there
could be cases of bogus family/other transactions.
16. Examining stocks /inventory & purchase transactions in particular
with related parties/sister concerns.
17. Identifying the type of fraud that has been operating, how long it has
been operation for, and how the fraud has been concealed.
18. Quantifying the financial loss suffered by the bank.
19. Gathering evidence to be used in court proceedings.
20. Providing advice to prevent the reoccurrence of the fraud.
21. The list is indicative only and a Forensic Auditor may be assigned
other jobs also within the ambit of Forensic Audit.
22. Details of all transaction with banks other than our bank.
23. Concentration transactions- sole customer, sole supplier, major
transactions with related parties/group companies, analysis of
relationship in two-way deals with the same party or indirect payments
made by customers of the borrower to the vendors of borrower,
24. Details of substantial debts raised in sister/associate/group
companies either through corporate guarantee of borrower or against
security of promotors or promoters’s family assets

CA. Ashwani Rastogi
Partner, ARJS & Associates
Chartered Accountants
Address- 2029, Bank St, Near Shreem Jewellers, Block 47, Beadonpura, 
Karol Bagh, New Delhi, Delhi 110005
Mobile Number+91-9990999281

No comments:

Post a Comment